DBRS Morningstar Finalizes Provisional Ratings on Freddie Mac Structured Pass-Through Certificates, Series K-127

DBRS, Inc. (DBRS Morningstar) finalized its provisional ratings on the following classes of Structured Pass-Through Certificates (SPCs), Series K-127 issued by Freddie Mac Structured Pass-Through Certificates, Series K-127 (Freddie Mac SPCs K-127):

-- Class A-1 at AAA (sf)
-- Class A-2 at AAA (sf)
-- Class X1 at AAA (sf)

All trends are Stable.

The Class X1 balance is notional.

With regard to the Coronavirus Disease (COVID-19) pandemic, the magnitude and extent of performance stress posed to global structured finance transactions remains highly uncertain. This considers the fiscal and monetary policy measures and statutory law changes that have already been implemented or will be implemented to soften the impact of the crisis on global economies. Some regions, jurisdictions, and asset classes are, however, feeling more immediate effects. DBRS Morningstar continues to monitor the ongoing coronavirus pandemic and its impact on both the commercial real estate sector and the global fixed income markets. Accordingly, DBRS Morningstar may apply additional short-term stresses to its rating analysis, for example by front-loading default expectations and/or assessing the liquidity position of a structured finance transaction with more stressful operational risk and/or cash flow timing considerations.

The collateral consists of 38 fixed-rate loans secured by 32 garden, high-rise, or mid-rise multifamily properties, two manufactured housing community (MHC) properties, one co-op property, one age-restricted property, one assisted living property, and one independent living property. All loans within the transaction are structured with 10-year loan terms. The transaction is a sequential-pay pass-through structure. DBRS Morningstar analyzed the conduit pool to determine the ratings, reflecting the long-term probability of loan default within the term and its liquidity at maturity. When the cut-off loan balances were measured against the DBRS Morningstar Stabilized Net Cash Flow (NCF) and their respective actual constants, 11 loans, representing 35.4% of the pool, had a DBRS Morningstar Term Debt Service Coverage Ratio (DSCR) at or above 1.80 times, a threshold indicative of a lower likelihood of term default.

Classes A-1, A-2, A-M, X1, XAM, and X3 of the FREMF 2021-K127 Mortgage Trust, Series 2021-K127 (FREMF 2021-K127) transaction have been conveyed into a trust by Freddie Mac to issue corresponding classes of SPCs guaranteed by Freddie Mac. All DBRS Morningstar-rated classes will be subject to ongoing surveillance, confirmation, upgrade, or downgrade by DBRS Morningstar after the date of issuance. DBRS Morningstar assigned the ratings to the FREMF 2021-K127 Certificates and the Freddie Mac SPCs K-127 without giving effect to the Freddie Mac guarantee. Please see the FREMF 2021-K127 Structural and Collateral Term Sheet for more information about the structure of the Freddie Mac SPCs K-127.

The loans benefit from strong origination practices and strong historical loan performance. Loans on Freddie Mac's balance sheet, which it originates according to the same policies as those for securitization, have an extremely low delinquency rate of 0.01% as of December 2020. This compares favorably with the delinquency rate for commercial mortgage-backed securities (CMBS) multifamily loans of approximately 3.89%. Since the inception of the K-Program through July 2020, Freddie Mac has securitized 20,359 loans, totaling approximately $414.17 billion in guaranteed issuance balance. To date, Freddie Mac has not realized any credit losses on its guaranteed issuances, although B-piece investors have realized a combined $18.8 million in total losses, representing fewer than 1.0 basis points (bps) of total issuance. The loans in the transaction benefit from experienced and financially strong borrowers compared with typical CMBS multifamily loans, with 34 of the 38 loans, representing 85.4% of the cut-off pool balance, receiving Strong DBRS Morningstar sponsor strength scores. Additionally, many of the borrowers are repeat clients of Freddie Mac that have performed as agreed.

Fifteen loans, representing 44.4% of the total balance, are in DBRS Morningstar Metropolitan Statistical Area (MSA) Groups 2 and 3. This compares favorably with the FREMF 10-year transactions in 2020, which averaged 35.6% in MSA Groups 2 and 3. Loans in MSA Groups 2 and 3 have historically had lower probabilities of default (PODs) and losses given default figures and are credit positive in the DBRS Morningstar model. The underlying collateral cash flow analysis is prudent, as an average DBRS Morningstar NCF variance of -6.4% on the sampled loans shows. This DBRS Morningstar NCF variance is slightly lower than the 8.6% DBRS Morningstar NCF variance in FREMF 2021-K125. In general, DBRS Morningstar sets revenue to levels similar to the recent trailing 12 months’ amount and lower than recent annualized rent rolls. The pool has generally strong occupancy metrics, with a weighted-average (WA) occupancy rate of 95.3%, based on the most recent rent rolls provided to DBRS Morningstar. On the contrary, only five loans, representing 10.9% of the cut-off pool balance, had an occupancy rate below 90%. Eight loans, representing 30.7% of the cut-off pool balance, have DBRS Morningstar property quality scores of Average + or Above Average. This compares favorably with FREMF 2021-K125 (24.8%), FREMF 2021-K123 (12.0%), and FREMF 2021-K122 (16.0%). Conversely, two loans (11.7% of the cut-off pool balance) had property quality scores of Average – and Below Average, compared with none in FREMF 2021-K123 and 1.7% in FREMF 2021-K122. The Water Terrace loan (Prospectus ID#6) was modeled with Below Average property quality because of an FBI raid that took place at the property on February 2, 2021, which resulted in the deaths of two FBI agents and one suspect. Below Average property scores are considered credit negative while Average + and Above Average property scores are credit positive in the DBRS Morningstar model.

Thirty loans, representing 82.4% of the pool by balance, have an upfront debt service reserve (DSR) designed to mitigate any potential impact of the ongoing pandemic. The reserves range from $97,000 to $2.3 million, depending on the property. Freddie Mac is generally requiring coronavirus-related reserves based on the property subtype and loan metrics at origination, and the reserves can be released back to the borrower if certain conditions are met.

In response to the ongoing coronavirus pandemic, Freddie Mac made changes to its standard servicing practices to permit a temporary deferral of loan payments and forbearance of various remedies that could, among other things, adversely affect cash flow. While DBRS Morningstar views the inclusion of coronavirus-related upfront DSRs for a majority of the loans as a positive mitigant to some of the potential coronavirus-related disruptions, the economic fallout from the ongoing pandemic continues to evolve. DBRS Morningstar generally expects multifamily properties to fare better than hospitality and retail properties; however, short- and medium-term challenges still exist in this sector. In addition to imposing various containment-related restrictions, certain jurisdictions have also placed temporary moratoriums on evicting tenants that may be continued, extended, or expanded. Furthermore, government programs, such as the Coronavirus Aid, Relief, and Economic Security Act, which provided, among other things, supplemental unemployment benefits to displaced employees, expired in March 2021. This could result in additional stress on properties whose residents have been disproportionately affected by furloughs and layoffs. In addition, the resurgence of coronavirus cases has created additional uncertainty and increased stress on the planned reopening of businesses. DBRS Morningstar also published its “Global Macroeconomic Scenarios: March 2021 Update” and is projecting generalized commercial real estate asset value declines for the U.S. of approximately 15% under its moderate scenario and 30% under its adverse scenario.

The overall credit metrics as evidenced by a WA DBRS Morningstar Issuance Loan-to-Value (LTV) and WA DBRS Morningstar Maturity LTV of 73.4% and 67.4%, respectively, are slightly worse when compared with FREMF 2021-K123, which had a WA DBRS Morningstar Issuance LTV of 70.9% and WA DBRS Morningstar Maturity LTV of 64.6%, and FREMF 2021-K122, with WA DBRS Morningstar Issuance and Maturity LTVs of 70.7% and 63.5%, respectively. This deal is more closely in line with FREMF 2021-K125, which exhibited a WA DBRS Morningstar Issuance LTV of 74.4% and a WA DBRS Morningstar Maturity LTV of 67.4%. Eleven loans, representing 26.6% of the trust balance, have Issuance LTVs of 75.0% or higher, which is also higher than FREMF 2021-K123 and FREMF 2021-K122 but lower than FREMF 2021-K125. As a partial result, the pool has a WA expected loss of 3.12%, which is higher than the WA expected loss of 2.96% for FREMF 2021-K125, 2.45% for FREMF 2021-K123, and 2.31% for FREMF 2021-K122.

Ten loans, representing 35.2% of the pool, have full-term interest-only (IO) payments. An additional 25 loans (including nine in the top 15), representing 61.5% of the pool, have partial IO periods ranging from 12 months to 84 months. The remaining three loans, representing 3.3% of the pool, have no IO period. For partial-IO loans, DBRS Morningstar calculates the POD using a DSCR that includes amortizing debt service. Furthermore, the DBRS Morningstar POD factors in loan balloon LTVs and, in cases where the loan lacks amortization, the balloon LTV will be penalized with a higher POD. The pool is concentrated by property type, as multifamily properties represent 96.6% of the collateral, which excludes two MHC loans, a co-op loan, and an assisted living loan that DBRS Morningstar modeled as a Limited Service Hotel to account for the operating risk associated with the property type. Compared with other property types, multifamily assets generally benefit from staggered lease rollover and lower expense ratios. While revenue is quick to decline in a downturn because of the short-term nature of the leases, it is also quick to respond when the market improves. DBRS Morningstar’s analysis of the 18 sampled multifamily loans indicates that most markets are displaying strong occupancy and rent growth figures, with positive year-over-year trends.

Individual loan information provided generally included monthly collection reports through September 30, 2020, which may not fully reflect any reductions to income as a result of coronavirus-related economic conditions. The DBRS Morningstar NCF analysis generally considered a vacancy loss that reflected projected submarket vacancy rates through 2026. These rates were either in line with or 100 bps to 200 bps higher than current submarket vacancy rates, adding a marginal amount of conservatism to the NCFs. Two loans, representing 6.9% of the total balance, are secured by the borrowers' leasehold interests in the properties. Furthermore, both of these loans, Hanover King Of Prussia (3.8%) and The Luxe At Katy (3.0%), have two of the highest expected losses in the pool. DBRS Morningstar estimated the ground rent expense as an average over the loan term. Additionally, DBRS Morningstar increased the cap rates for Hanover King of Prussia and The Luxe at Katy by 2.0 and 1.1 percentage points, respectively, and modeled them with Average sponsor scores.

The sixth loan in the pool, Water Terrace, was the location of a deadly FBI incident that took place within the subject collateral on February 2, 2021. Two FBI agents were fatally shot and three agents were wounded in a shootout as they executed a search warrant on one of the units of the property. The subject of the warrant, who was a tenant at Water Terrace, was also killed. DBRS Morningstar applied a Below Average property quality score and adjusted the cap rate to 5.25% from the Issuer’s implied cap rate of 4.81% to account for the anticipated short-term performance decline. For more details on this loan, please refer to the individual loan analysis in this document.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Class X1 is an IO certificate that references a single rated tranche or multiple rated tranches. The IO rating mirrors the lowest-rated applicable reference obligation tranche adjusted upward by one notch if senior in the waterfall.

All ratings are subject to surveillance, which could result in ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.

For supporting data and more information on this transaction, please log into www.viewpoint.dbrsmorningstar.com. DBRS Morningstar provides analysis and in-depth commentary in the DBRS Viewpoint platform.

DBRS Morningstar provides updated analysis and in-depth commentary in the DBRS Viewpoint platform for the following loans in the transaction:

-- Prospectus ID#1 – Oakfield Apartment Homes & Wyndover Apartment Homes (7.3% of the pool)
-- Prospectus ID#2 – Renaissance Bay (6.4% of the pool)
-- Prospectus ID#3 – Florida MF Portfolio (5.5% of the pool)
-- Prospectus ID#4 – The Mark At Brickyard (5.4% of the pool)
-- Prospectus ID#5 – Luxor Club (5.3% of the pool)
-- Prospectus ID#6 – Water Terrace (4.4% of the pool)
-- Prospectus ID#7 – Firenze Apartments (4.2% of the pool)
-- Prospectus ID#8 – Hanover King Of Prussia (3.8% of the pool)
-- Prospectus ID#9 – Gloria Homes Apartments (3.8% of the pool)
-- Prospectus ID#10 – Alanza Place (3.6% of the pool)
-- Prospectus ID#11 – Harbor Landing Apartments (3.5% of the pool)
-- Prospectus ID#12 – The Churchill (3.4% of the pool)
-- Prospectus ID#13 – The Heights At Sugarloaf (3.4% of the pool)
-- Prospectus ID#14 – Vivace At Gateway Place (3.3% of the pool)
-- Prospectus ID#15 – The Luxe At Katy (3.0% of the pool)

For complimentary access to this content, please register for the DBRS Viewpoint platform at www.viewpoint.dbrsmorningstar.com. The platform includes issuer and servicer data for most outstanding CMBS transactions (including non-DBRS Morningstar rated), as well as loan-level and transaction-level commentary for most DBRS Morningstar-rated and -monitored transactions.

Notes:
All figures are in U.S. dollars unless otherwise noted.

With regard to due diligence services, DBRS Morningstar was provided with the Form ABS Due Diligence-15E (Form-15E), which contains a description of the information that a third party reviewed in conducting the due diligence services and a summary of the findings and conclusions. While due diligence services outlined in Form-15E do not constitute part of DBRS Morningstar’s methodology, DBRS Morningstar used the data file outlined in the independent accountant’s report in its analysis to determine the ratings referenced herein.

The principal methodology is the North American CMBS Multi-Borrower Rating Methodology (August 7, 2020), which can be found on dbrsmorningstar.com under Methodologies & Criteria. For a list of the structured-finance-related methodologies that may be used during the rating process, please see the DBRS Morningstar Global Structured Finance Related Methodologies document, which can be found on dbrsmorningstar.com in the Commentary tab under Regulatory Affairs. Please note that not every related methodology listed under a principal structured finance asset class methodology may be used to rate or monitor an individual structured finance or debt obligation.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308.

For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the rating process.

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at [email protected].

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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